A six-month European call option's underlying stock price is $86, while the strike price is $80 and a dividend of $5 is expected in two months. Assume that the risk-free interest rate is 5% per annum with continuous compounding for all maturities.
1) What should be the lowest bound price for a six-month European call option on a dividend-paying stock for no arbitrage?
2) If the call option is currently selling for $2, what arbitrage strategy should be implemented?
1) theoretical price = $2.85
1) theoretical price = $3.02
1) theoretical price = $3.67
1) theoretical price = 1.98
arbitrage strategy: Buy the call and short the stock.
2) arbitrage strategy: Buy the call and buy the stock.
2) arbitrage strategy: Short the call and buy the stock
2) arbitrage strategy: Short the call and sell the stock